Thursday, April 12, 2018

Intellectual property

The China trade argument has boiled down to intellectual property and trade. Roughly it has gone like this:

"We need to stop China from selling us all this stuff. Bring the jobs home!"

"Uh, right now the jobs problem is that employers can't find workers. Cheap stuff from China is a boon to American consumers. Tariffs like that on steel cost more steel-using jobs than they save."

"Hm. Ok, but we have to threaten with tariffs to get China to stop requiring our companies to share intellectual property!"

I'm still skeptical about the intellectual property and trade argument. OK, suppose China says that in order for a US company to produce there, it must share intellectual property with a Chinese partner. Just how terrible is this? Just how terrible for the US economy, and society as a whole, justifying a robust policy response -- obviously the company would rather make more profits, but that's not a basis for economic policy.

Because of this feature, intellectual property is quite different in law, and in economics, than other kinds of property. Ideally, once an idea is produced, it should be distributed freely to everybody. The marginal cost is zero, it is nonrival, so society is best off if everyone gets to use new ideas immediately. Economic growth is the spread of better ideas, and the faster the better. Period.

Except... it costs money to produce new ideas. So if we have no intellectual property rights, nobody produces intellectual property to begin with.

Our patent, copyright, and intellectual property system is, ideally, a response to this conundrum. We grant innovators a monopoly right to new ideas. They can then recoup the cost of developing the idea. But a patent requires disclosure of the idea, and only lasts a finite amount of time. After the inventor is rewarded, the idea becomes public property and everyone can use it. In this way patent rights are not universal, nor eternal, unlike say physical property rights (ideally).

We have a lot of other institutions designed to address this problem. Research universities receive nonprofit status in return for producing and disseminating nonrival ideas. The government funds a lot of research for the same purpose.

"Technology transfer" is one of the main tools of external development efforts. People go to less developed countries and try hard to help them to use US-developed ideas. For free. It is part of many contracts in our world of politicized international business, such as airplane construction.

Medicines are a good example. They are developed at great cost. The US consumer gets them first and pays through the nose. Eventually it goes generic, and spreads to other countries. Soon, we're subsidizing its use in the third world.

China's rise has been amazing. But their GDP per capita is still only $8,000. US GDP per capita is $58,000. They desperately need to learn how to do things as we do.

Now, yes, stealing intellectual property is not good, and the world is right to complain. Though remember, at a similar stage of development, the US stole a lot of IP from the UK. We only started a manufacturing industry because some clever spies stole the designs to power looms. And our publishing industry routinely republished UK books, like Dickens novels, without paying a cent of IP. It's not clear that US growth came at the expense of the UK in the 19th century, and by 1917 they were kinda glad to have us around.

But the question at hand is, just how much is the US, and the world as a whole, damaged by China's demand that companies who want to set up shop there share intellectual property with Chinese partners, i.e. teach them how to do things?

The companies can always say no. If you're going to lose more by losing some of the monopoly power of your idea to a Chinese partner than you gain by being able to produce in China or sell there, don't do it! Or demand a better price. It sounds like companies want just to increase their monopoly profits. Well, I understand completely why the companies want that -- having your cake and eating it too is nice. And if the White House can get it for you, go ask for it. But a desire to increase monopoly profits is not a social or economic problem. Companies could also increase profits if the US lengthened patents to 50 years. But we don't do that -- we understand the importance of "forced technology transfer" for ideas.

In fact, this IP debate is quite a contradiction with the other argument going on right now. The Economic Problem of the Minute, (we seem to have a new one every 20 minutes) is too much "monopoly" power. Profits are up, labor's share is down, investment is down. It looks like companies are sitting on "rents," i.e. the monopoly power they have from unshared intellectual property.

And so...we want to strengthen the rents, the monopoly power of intellectual property?

There is a parallel strain of economic thought that says we have too much intellectual property protection. The point of trade agreements should not be to preserve the Mickey Mouse copyright for another 100 years, and all over the world. Walt made his money. Tech is wasting a lot of time and money on patent wars.

It is possible that R&D is not happening that could happen, but it is so costly that only joint US and Chinese monopoly rents could justify. New ideas not produced are the clearest argument for social cost of technology transfer. But I don't hear that argument. I hear only, US firms developed great stuff, they're making money on it, they want to produce with cheaper labor in China. They still make money if they share the technology. But they want to make more money yet, and they're not willing or able to demand a better price for their technology or walk away from the table.

To be clear, I don't think government-imposed forced partnerships are a good thing, nor is forced technology transfer as a condition of doing business in a country a good thing. I would rather, and we would all be better off, if China allowed businesses to operate freely, or at least as freely as they do in the US. (We're no saints here on allowing foreign businesses to do what they want.) But like tariffs, which mostly hurt the country that imposes them, it does not seem like an obvious social problem over which to start a trade war.

25 comments:

Great stuff. But one of the big effects of the US joining up with TPP is that the now-dormant intellectual property clauses that confer rents on existing IP holders by extending the term of existing copyrights will become live.

I'm a NZ-based fan of TPP, but I'm not sure the current group should let the US in - and especially where the current administration seems pretty happy to violate the spirit of existing trade agreements for domestic political gain. Why should the rest of the TPP countries expect that the current administration will play fair if allowed in?

From an Australian point of view the TPP generates almost no gains on trade and generates losses on IP. Moreover they're unconscionable losses – from extensions to IP which are retrospective and overwhelmingly likely to generate more costs than benefits on a global scale – and quite possibly even in the US given how much IP like software patents are impeding innovation without stimulating any new activity that one can see.

yes, IP involves a tradeoff b/w innovation and monopoly rents but in this particular case, why should US companies share IP that they're currently developing for which they haven't received a return yet? technological advances in electrical vehicles and autonomous driving are ongoing and far from reaching their potential.you're also underestimating china's ambitions to eclipse the US as global hegemonic power. part of the effort to achieve that involves import substitution of US exports laid out in Made in China 2025. as you said, our IP theft of British inventions helped our economy thrive which proved to be beneficial to them in WWI and WWII. but how many times has China opposed us in military conflicts? are you so sure that China is a kindred spirit that shares our democratic values?

The problem is that companies do not have the choice of deciding whether to share IP when entering China. The are forced by Chinese government edict to do so. And if one side brings a gun to a knife fight don’t blame the other for arming up especially in what they know will be an iterative long term game.

As someone who constantly rails against government interference in private arrangements I am surprised you seem to downplay this. (And I generally like your arguments!)

I want to invest X in company Y. Deal is marginal and risky. Government forces me to pay 30% tax if t works out, and the investment payoff no longer makes sense to me.

Per your argument you would say -- you don't like the deal (with the tax enforced), feel free to walk away.

If Chinese government was not forcing IP transfer I would have the following choices

(i) walk way(ii) have manufacturing done by China for lower costs, but not reveal my IP(iii) have manufacturing done by China, and give up my IP because I believe I may get more benefit by eg having Chinese engineers work on extending it for local market, or indirectly (Tesla open-sourcing their IP in hopes of getting a bigger market) or decide to be an altruist (Salk)

The Chinese policy removes choice (ii).

I really don't see a difference. Taxes can be used for good. Forced IP transfer may benefit China in some way. Either way, government is getting involved in a major way in private contracts. And saying 'if you don't like (an opportunity we are interfering with for our own reasons), you can always walk away' is both true but not very helpful. Am I missing something?

From a Canadian point of view, the TPP would have extended the reach of the dysfunctional American IP system. Trump has said that TPP has to be substantially better for USA so the USA joining TPP is going nowhere for the time being.

A demand that companies transfer technology as a condition of doing business in China is a non-tariff barrier to American companies doing business there and the US is right to deal with it on a nation to nation basis - just as they would be right to negotiate mutual tariff rates.

There is a small irony in the Trump push for more IP protection. If, for example, China respected Microsoft's IP and started paying royalties for all the pirated copies of Windows and Office then, ceteris paribus, Chinese exports of goods to US would go up slightly and Chinese imports of goods would go down slightly so China could pay the royalty.

I used to be a big proponent of free trade until I saw the numbers, which are not really discussed in your article. China buys $130b from the US and sells us $505b each year. They are earning a gusher of dollars every year and the ruan/tuning should be sky rocketing. It's because they are in an economic war with us, we just didn't acknowledge it. Smaller but similar results with Japan, Germany and Mexico. They can't "beat" us or we can't "lose" a trade war simply because they don't buy enough of our goods for tariffs to really hurt our economy. Our poetics will go up a little, Our jobs will go up more. Hopefully they will realise what will happen and we can get back to"fair" trade. The US has been subsidizing the world for fifty years. That was fair after ww2 but eventually it needs to stop. Now's the time.

The United States is borrowing from Asia and Europe. When the loan gets "advanced", the lenders don't ship over bales of yen, renminbi, won or Euros - they ship over cars, cell phones, televisions. You want to balance trade - stop borrowing off shore. Right now Trump is playing whack-a-mole trying to pound down some imports but so long as the USA keeps borrowing a different import will pop up to balance the books.

To complicate matters, some of this happens as three or four way trades. For example, South Korea might buy treasuries and then sell components to China who incorporates them into cell phones which go to America which then says it has a huge trade deficit with China when it was the Korean lending and components that really drove the deficit. To make things even more complicated: some of those cell phones will go to Mexico which then ships cars to the United States to close the circle and America accuses Mexico of cheating. Mexico runs a roughly balanced trade with the world so the deficit with Mexico is probably driven by the borrowing from Asia and Europe.

The one good thing about American (and to a lesser dollar amount Canadian) fiscal deficits is that they are soaking up excess world savings that might otherwise send the world into a deflationary spiral. Better solution would be if either Asian and European savings rates were reduced or the savings were directed to developing the under developed world. We should all be cheering on the Chinese OBOR investments.

Exactly. Why cannot American companies thinking about investing in China simply refuse if the conditions are viewed as too onerous?

Are American multinational companies and entrepreneurs so blindly greedy that they require a paternalistic state to help them make decisions?

Ironically, foreign direct investment has long been viewed as positive for host nations precisely due to the transfer of technology acquired largely through learning by doing.

There are plenty of emerging markets and other developing nations with characteristics similar to China (minus the former one-child policy) that are very attractive for foreign investment and not demanding at all in terms of mandated technology transfers.

Brazil for most of this century had crushing local content requirements. Smart multinationals, particularly in the sensitive resource sectors, stayed away. Others enjoyed spinning their wheels and making negative returns.

If you believe that companies are like obese American adults that should lose weight, then that is a good thing. The question is should the American state help private companies risk-manage their financial decisions?

What John said makes great economic sense if China has similar economic and political systems. When American companies share their IP with Chinese partners, they start other business and sell same products at lower prices, basically kicking you out of business. The money made by Chinese companies mostly goes to a small group of people and the authoritarian government. The majority of the Chinese people are not better off from the growth. Rather, they get less freedom and more distant prospect for democracy. Even worse, the government uses the money to promote its ideology and influence. If not curbed, the whole world will be worse off in the end.

Cochrane's more salient point, firms are not forced to set up shop in China. There are many developing countries that attract Foreign Direct Investment as a result of trade rule liberalization. To Attract foreign investment and tech transfer, protecting IP rights must be a prerequisite. Otherwise, why invest in those countries? Developing countries import inputs for production in their countries that are partly underwritten by investing foreign entities.

Out of curiosity, does the timing matter for your arguments? My understanding is that China originally demanded partnering with a local firm (for banks anyways) and then moved to forced IP transfer. That seems like an ex post change in law after an irreversible investment (sunk cost and all that).

Also, Google shouldn't bow to Chinese pressure for enforcing censorship. Should the US ignore such humanitarian issues just because Google could choose not to do business there? Similarly, is the forced transfer or how it was implemented contrary to international norms which argues for a state response?

John’s post is interesting and useful but I might comment/challenge two points.

First, there is the claim “..stealing intellectual property is not good, and the world is right to complain.” A sovereign nation is under no obligation to obey the laws of another country. Driving 85 mph is speeding on most US roads but it is not speeding on many German roads. The Chinese have no more legal duty to respect the copyright on a Disney movie than we had to respect the copyright for a Dickens novel. (And, no, it doesn’t help to say that when the Chinese bootlegger acquired the original copy of the movie he entered into some sort of contract of adhesion agreeing not to duplicate the movie. The Chinese courts are under no more obligation to enforce that contract than they are to enforce the copyright without the contract.) Now you might want to argue that using intellectual property without permission is unethical. And you might want to argue that as a matter of sound economic policy the Chinese should respect intellectual property created in another country. In fact, I’d make both of those arguments. But that’s different than claiming the Chinese are stealing.

Second, there is the claim “Intellectual property is different from real property.” (And I think it’s clear from the context that by “real property” John means more than land, improvements and fixtures.) True, IP is an example of a purely non-rivalrous good, meaning the marginal cost of another use is zero. But there’s nothing special about zero. It turns out that there are lots of things out there for which the marginal costs are low relative to fixed costs. This means you can’t sell every unit produced at marginal cost—doing so lead to losses since you couldn’t recover fixed costs. (Think, air transportation, electricity, cable TV, lots of relatively low tech manufactured goods ……) But markets have ways of resolving the problem. Airlines are making decent money these days. That’s important to point out since it reminds us of all the mischief that’s been done in the name of resolving a “market failure” in a high fixed cost industry. High fixed costs/low marginal costs were the justification behind, among other things, the regulation of airlines, telecommunications and retail electric markets. John’s not likely to fall prey to that error but just agreeing that IP is radically different than any other type of property is a slippery slope.

"We need to stop China from selling us all this stuff. Bring the jobs home!" "Uh, right now the jobs problem is that employers can't find workers...."

That's not the argument. It's more along the lines of "Bring home nostalgia inducing Job X in Specific Place Y!"

Now as a matter of economics, the real argument is no better than your version. It might even be worse. But as a matter of politics, the real argument is a LOT more compelling.

I mean look, we all get that the old steel mill communities are as good as dead (or at least those of us living outside of them do). But that doesn't make the plight of those living in such places easier to stomach; it must be a very hard thing seeing a community your family has been in for generations falling apart so quickly. I might also be prone to suspending disbelief and believing in tariffs as a real solution if placed in the same situation.

I expect that the nostalgia is for job X that paid higher than average wages.

Some industries will have paid high wages historically because: they were capital intensive and as a result the employer was less price sensitive on wages; or the employer was part of an oligopoly and workers were able to piggy back. Steel, oil and cars would historically fit in both categories.

The above market wages flowed from some degree of monopoly giving pricing power. International trade has challenged such national monopolies in goods that can be traded.

Trying to protect local jobs can be hideously expensive. The United States is currently protecting lumber jobs at a time of record high lumber prices. The CATO institute has estimated that protecting lumber jobs costs American consumers approximately $1,000,000 per year per job. It seems likely that the move to protect steel and aluminum production jobs is going to have a cost with the same order of magnitude.

More of a question than a comment, and it is tangential, so I apologize: Why do economists not complain about software copyrights and patents more? The IT industry is described as hyper-competitive, but seems to be dominated by a small number of gigantic companies. That would seems to me that the IP protections afforded the IT industry are too strong if the industry subsectors often results in domination by one or two companies. But I am not an economists and so I am not sure if I am looking at this correctly.

Please publish this in WSJ oped ... public and pols need to be educated on virtues of free trade and that China is not "forcing" anyone to transfer technology. Without foreigners subsidizing our investment/savings imbalance, we would be in a much worse position.

"Society" is better off. But, we're not a society. China isn't in the same "society" as the US. We have this term society for a reason. It defines boundaries. It defines who isn't and isn't in it.

Second, "we did it too" isn't much of an argument. We did it too, and now we're way ahead of the UK and the UK is a stagnant country (and has been for the better part of a century). Something to do with capital and ideas moving to the US sometime in the late 19-th early 20th century.

Isn't that a good reason to argue why we shouldn't let it happen to us? We know the consequences.

Third, you're focusing on costs of developing IP. But that only matters in so much as IP creates value. If everyone gets it, it's no longer valuable to the firm/country where it was developed. Hence the problem with preventing IP from being "stolen" or forced to be transferred elsewhere.

Sure, you can argue about all the potential benefits this may bring to the US. But one would be hard pressed to argue that those benefits don't come with some huge costs. Eroding your core competency (which for the US is R&D) is unlikely to be a good idea, regardless of the potential "benefits" which may arise. The costs of making yourself redundant are...probably...bigger in the long term.

This is one of the best dialogues I've read. I've never completely understood the concern over trade deficits. They sound scary but all we've done is exchange cash for goods that we value more. We have less cash in the US but more goods. So?

It's true that some argue about the incentive that comes with intellectual property and being able to monopolize it as a reward, but if you think of it, the earlier intellectual property is shared the more time it gives others to use it and perhaps develop upon that idea, because more individuals are better than 1. Requiring companies to share intellectual property opens a new path for growth as the idea is no longer just for inside usage but anyone within that industry can use it to create more intellectual property also known as shared R&D in a sense. Despite China's GDP per capita compared to the US, their growth as a country is amazing so there must be something that they're doing right. Honestly, I think intellectual property should be shared because someone has the opportunity to add to the idea. However, there are certain regulations that should be set with the idea of sharing intellectual property.

I believe that Mr. Cochrane makes some very strong arguments. Patents and other forms of intellectual property are non-rival as you argue and are excludable public goods. I do wonder how much their would be an incentive for people to produce goods if all ideas were a public good. Essentially, patents provide an incentive for people to invest and invent. It is interesting because the Netherlands is considered to be one of the first modern economy by Jan de Vries and Ad van der Woude. The country had free access to functioning markets, division of labor, and a government that enforced property rights along with intellectual property such as patents. Under the World Trade Organization they in the past have been discussing to reduce trade generating tariffs agricultural trades and intellectual property. But it is worth mentioning that during the Industrial Revolution there were scientific societies formed who offered prizes to innovators to discourage them from seeking patents since they were more concerned with open knowledge.

I believe that Mr. Cochrane makes some very strong arguments. Patents and other forms of intellectual property are non-rival as you argue and are excludable public goods. I do wonder how much their would be an incentive for people to produce goods if all ideas were a public good. Essentially, patents provide an incentive for people to invest and invent. It is interesting because the Netherlands is considered to be one of the first modern economy by Jan de Vries and Ad van der Woude. The country had free access to functioning markets, division of labor, and a government that enforced property rights along with intellectual property such as patents. Under the World Trade Organization they in the past have been discussing to reduce trade generating tariffs agricultural trades and intellectual property. But it is worth mentioning that during the Industrial Revolution there were scientific societies formed who offered prizes to innovators to discourage them from seeking patents since they were more concerned with open knowledge.

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About Me and This Blog

This is a blog of news, views, and commentary, from a humorous free-market point of view. After one too many rants at the dinner table, my kids called me "the grumpy economist," and hence this blog and its title.
In real life I'm a Senior Fellow of the Hoover Institution at Stanford. I was formerly a professor at the University of Chicago Booth School of Business. I'm also an adjunct scholar of the Cato Institute. I'm not really grumpy by the way!